What is an Employee Ownership Trust (EOT)?

Employee owned companies have existed in the UK for decades and are becoming an increasingly popular ownership model by businesses across many sectors. Employee Ownership Trusts have become the most common way that UK based businesses move into employee ownership.

Employee Ownership Trusts (EOTs) allow employees to gain indirect ownership of a company through a trust structure. By acquiring a controlling interest, the EOT holds shares for the long-term benefit of the employees.

Why choose to sell to an EOT?

Many business owners are opting to sell to Employee Ownership Trusts (EOTs) as a succession strategy instead of selling to a third party or using traditional internal exit routes like a management buy-out. Here are some reasons why:

  • Preservation of Business Values: Employee ownership helps maintain the business’s core values, culture, and legacy, as well as its geographical location and community ties.
  • Employee Rewards: It rewards employees who have significantly contributed to the business.
  • No Need for External Buyers: Selling to an EOT eliminates the need to find an external buyer and ensures a fair price for the shares.
  • Separation of Leadership and Ownership: Leadership succession focuses on finding the best people to run the business, not necessarily those who can afford to buy shares.
  • Flexible Transition for Owners: Owners can step back from the business on a timeline that suits both them and the business.
  • Control Over Sale Process: Sellers have significant control over the sale process, terms, and timeline.
  • Long-term Succession Security: Holding shares in an EOT secures long-term succession, allowing the business to invest and grow without the distraction of buying out the next generation or appealing to trade buyers.
  • Job Protection: Selling to an EOT protects employee jobs, which might be at risk in a third-party sale.
  • Enhanced Business Performance: Employee-owned businesses tend to be more innovative, productive, and resilient.

What are the tax benefits of an EOT?

  • Capital Gains Tax Relief: Sellers can transfer shares to an Employee Ownership Trust (EOT) without incurring capital gains tax.
  • Income Tax-Free Bonuses: Employees can receive certain bonuses free from income tax, up to £3,600 per year.
  • Qualifying EOT Requirements: To qualify, the trust must hold a majority (more than 50%) of the company’s shares.
  • Compatibility with Other Schemes: An EOT can be combined with other tax-advantaged share schemes like Enterprise Management Incentive (EMI) options and Share Incentive Plans (SIPs).

How is the sale of shares to an EOT funded?

Typically, the company needs to finance the share purchase since the Employee Ownership Trust (EOT) lacks its own income or assets. Third-party funding can sometimes be used if it suits all parties involved.

More commonly, there will be an upfront payment at the completion of the share sale, funded by surplus cash and the remaining balance will be paid in instalments over several years, funded by the company’s profits.

Are there any Qualifying Conditions?

To benefit from tax reliefs, certain conditions must be met:

  • All Employee Benefit Requirement: All eligible employees must benefit from the EOT, excluding those who own 5% or more of the company’s shares.
  • Equality Requirement: Benefits must be distributed equally, though they can vary based on remuneration, service length, and hours worked.
  • Controlling Interest Requirement: The EOT must acquire and maintain more than 50% of the company’s share capital, voting rights, and profit entitlement.
  • Limited Participator Requirement: The number of 5% shareholders who are also employees must not exceed 40% of the total workforce.
  • Trading Requirement: The target company must be a trading company or the holding company of a trading company.

Disqualifying Events

There are certain events which can result in a breach of the qualifying conditions, triggering tax consequences.

Conclusion

While EOTs offer significant benefits, including tax advantages and enhanced employee engagement, careful planning and adherence to qualifying conditions are crucial for maximising their potential.

For more information on EOTs, please contact Alison Price, Partner on a.price@uhy-uk.com or 01462 687333. You can also download our Guide to Employee Ownership Trusts.